As a reminder to all, the Red Sky Report is delivered on an as-needed basis. Effectively, when there is something noteworthy to report, you’ll hear all about it with several pieces covering the action in short order. When trends are persistent and we’ve already discussed much of it, we won’t jam up your already bloated inbox. Ok?I can see you nodding your head. For this update, as a reminder, I’ll simply touch base on current trends that have been firmly in place since early to mid-2016. Despite our collective expectations for one outcome or another, nothing has changed. This is where your money should be invested factoring in both risk and reward properties.
Markets in an Uptrend
We are still in a bull market and last week the US market confirmed another all-time new high. Nothing new. Pullbacks to the shortest of trend following type moving averages, like the 50-day moving average, have seen opportunities for buyers to step up and either add new positions or add to existing positions from cash. Someday, this buy-the-dip pattern will give way and the trend will not hold, leading to a deeper correction or perhaps a new bear market. However, seasonally, this is the tough phase of the year as mid-July through mid-September can be some of the most challenging. We’re purposely carrying some higher cash now to create a smoother ride through this time, considering the pending showdowns in Congress, earning season directly ahead, worrisome valuations, and a less accommodative Federal Reserve. It’s the right thing to do knowing that we’re leaving some potential return on the table.
Internationals
The strength in internationals is one of the most persistent and rewarding trends in today’s global market place. It’s an exciting and dramatic change in the leadership of world markets, which has grossly favored US Index investing for the better part of 20 years. Today, the US market is rising, yes, but not like the rest of the world. The combination of our country’s stagnant growth rate (can’t seem to get above 2% annually), current aggregate market valuations (one of the highest in the world), tightening monetary policy (now three rate hikes in) and the great many concerns surrounding Trump, makes the US relatively unattractive for investments. Conversely, almost the exact opposite set of variables can be found in much of overseas financial markets with varying degrees of strength, all of which are outperforming the US. Today, the equity portion of our strategies are largely invested outside the US and only lightly invested in the US. We intend to add to our internationals as we see opportunities and entry points to do so.30-40% internationals in one’s portfolio now is reasonable and I believe that is the first time in my 25-year career that I have ever said that.
Take a look at the chart below from Bespoke, specifically the YTD numbers for internationals.WOW!
Playing the Interest Sensitive Space
Going into 2017, there was a very strong investor preference for bond proxy type investments. These are the funds that pay dividends or interest but aren’t quite bonds. Preferred securities, convertible securities, dividend ETFs, high yield corporate bonds, etc. Generally, all have lagged the non-interest bearing stock indices and the relative strength continues to decline. Conceptually, bond proxies tend to struggle in a rising interest rate environment and make no mistake, this is a rising interest rate environment. While our guiding High Yield bond signal has not yet tripped to a formal sell, the asset class and everything in the High-Income space is now unattractive from a credit spread perspective. If Treasury bonds want to go for another run higher (price) and yields fall toward zero or even negative rates like Japan, then one could make the argument that High Yield might have more room to run. But then again, if Treasury bond yields are going negative, our focus will be on capital preservation more than anything. At this point, we’re going light on bond proxies and planning to take profits on all in the near future.
Note – Earlier this month, we again reduced our “Equity Income” sleeve in the All Season Strategy by 5% (down to 10% of total) and added the same percentage to our “World Stock Index” Sleeve bringing it up to 40% of total. These types of tactical allocation changes are reviewed and executed quarterly.
Real Estate is a hold for us now and a nice diversifier to most portfolios. Strangely enough, real estate and REITS hold up relatively well in a rising rate environment, much more than most understand. Today, they are lagging stocks a bit but still in a nice stable uptrend, offering investors regular entry points, dating back to Feb of 2016. Jared Dillon who writes a brilliant regular column called “The 10th Man” did an excellent update last week on a developing opportunity in Retail Malls, even Retail REITs.What?I know, sounds crazy but he makes a pretty compelling argument that retail stocks and associated REITS are now battered and hammered to the place where the value guys with icy veins, like Buffett, will start accumulating. Maybe retail is dying as an industry relative to on-line sales but it will never really disappear according to Jared. We’re doing our homework now. Remember when Buffet was so crazy to buy Goldman Sachs at the bottom of the financial crisis. Remember when he bought Burlington Northern and everyone said he had lost it. How about those IBM and Wells Fargo bets. Now they are all HUGE winners. Value investing is insanely tough emotionally, dangerous in terms of finding a bottom and very lucrative if done right.
Sectors, Styles and Size
Nothing much has changed here with one exception. Value is trying to re-establish itself as the leadership group above Growth. We can’t say that it’s really happened yet but we are seeing a lot of selling and new volatility in technology while there is some obvious accumulation in things like financials, transportation, materials and industrials. Small caps continue to underwhelm but look constructive. Beyond that, there isn’t really an edge anywhere.
That’s about all there is to report of interest but again, not much new. These are trends that have been in place for almost a year. Our quarterly statements were delivered last week and they included a complete second-half market forecast. We would encourage you to read these quarterly updates where we take a longer-term view of the market and economic conditions in order to guide your expectations. Note, market internals are now hinting at a potential US recession by mid-July 2018. As always, we are here for you to discuss your personal situation or help with any decisions you are considering. It’s critically important to understand the current and future economic environment when making any significant financial decisions (housing, moving money around, business prospects). Please consult with our team of wealth managers first!
That’s if for now – enjoy the summertime!
Sam Jones
